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01/30/2011

Inequality in Income and Wealth—Posner

In discussing inequality of income and wealth (I’ll use “inequality” to cover both) one could focus on inequality between countries—rich countries versus poor countries—or on inequality of wealth within countries. The two inequalities could change at different rates, even in different directions. I will focus, as does Becker, on inequality within countries.

As he points out, it has grown. This seems to be the result of four forces: (1) a trend away from redistribution—that is, from policies designed to equalize after-tax incomes by combining heavy income taxation with subsidies for poor people; (2) greater competitiveness, in part because of deregulation, more rapid innovation, freer international trade, and a decline in discrimination; (3) the growth in the size of markets (this is related to freer international trade), which increases the returns to excellence and innovation; and (4) an increasing return to IQ because of the changing character of production. The first three points are related to the collapse of communism and the failure of collectivist policies in noncommunist countries (notably the failure of regulation in the United States in the 1970s and the ossification of labor unions despite government support), and the last to the decline of manual labor relative to brain work as economic activity becomes increasingly automated as a result of technological progress. Most commentators on inequality would reword (4) as an increasing return to higher education, but it is very difficult to gauge the value added of a higher education, especially the economic value. Think of such college dropouts as Bill Gates, Steve Jobs, and Mark Zuckerberg. Higher education is indispensable for persons who want to be members of professions, and doubtless helpful for most people who want to go into business, but it will not make up for deficiencies in IQ.

Compare two people, A and B. A does not go to college, and his lifetime earnings are $1 million. B goes to college, and his lifetime earnings are $2 million. In gauging the value added by a college education, one has to control for, among other things, difference in both cognitive and noncognitive abilities (IQ illustrating the first, ability to apply oneself to a task the second). The point is not that B didn’t derive a benefit from college. Maybe without college his lifetime earnings would have been only $1 million too. But maybe if A had gone to college, his lifetime earnings would still be only $1 million because he wasn't smart enough, or motivated enough, to derive any benefit from college. The University of Chicago economist James Heckman may well be right that the only hope for many Bs is early childhood intervention.

Thus the question is whether today in America everyone who can benefit from a college education gets a college education. If so, increasing college enrollments would not reduce inequality, though school reform at the high school and elementary school levels might increase the number of persons who can benefit from a college education, although Heckman’s research provides a basis for skepticism.

Inequality is self-limiting to a degree; if it generates tremendous envy and resentment, the government will be under irresistible pressure to adopt redistributive policies. (Equality is likewise self-limiting: too much, and it destroys incentives.) Oddly, increased inequality in the United States has not generated much envy or resentment. The principal opponents of inequality are upper-middle-class liberals rather than poor or lower-middle-class people, and they failed to obtain a rescission of the Bush tax cuts for high-income taxpayers. Obama’s health care reform is the only major redistributive measure adopted in the United States in recent times, and its major redistributive component is an expansion in Medicaid, which the states (which pay half the cost of Medicaid) are busily trying to undermine by reducing the medical treatments for which Medicaid will reimburse providers of health care.

If I am correct that inequality is not influencing public policy in the United States—is just not a political issue—then I don’t think there is an inequality “problem.” There is just the facts that in the United States a small fraction of the population has an enormous share of the nation’s income and wealth and, at the other end of the income distribution, there are many very poor people. Are the rich a “problem”? I don’t think so. All their money is either spent on consumption or invested, and either way it is economically productive; it’s not as if the rich hoarded their wealth in the form of gold bars. The rich influence elections by their campaign contributions, but they would have the same influence with much less money, because it is not the absolute level of a rich person’s campaign contributions that sways elections but the level relative to contributions by other rich persons supporting competing candidates.

Warren Buffett warns that without stiff inheritance taxes (which the United States does not have), we will find ourselves in the grip of an “entrenched plutocracy” (according to the Economist article that Becker cites). I don’t understand that concern. The heirs of the rich spend their money on consumption or investment, just like their parents; dissipate it rapidly, if they’re dumb; but in any event do not by virtue of having inherited a lot of money block the upward striving of others.

Poverty is a problem, but if the rich are not a problem, then the problem of poverty is not a problem of inequality. It looks like a problem of inequality only because the wealth of the wealthy seems an obvious source of money to alleviate poverty. But it is not that taxing the rich would alleviate poverty, but that taxing the rich and using the tax revenues to raise the incomes of the poor would alleviate poverty. Inequality should be a non-issue in the United States—and to a considerable degree it is.

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"If I am correct that inequality is not influencing public policy in the United States—is just not a political issue—then I don’t think there is an inequality “problem.” There is just the facts that in the United States a small fraction of the population has an enormous share of the nation’s income and wealth and, at the other end of the income distribution, there are many very poor people.

Are the rich a “problem”? I don’t think so. All their money is either spent on consumption or invested, and either way it is economically productive; it’s not as if the rich hoarded their wealth in the form of gold bars.

The rich influence elections by their campaign contributions, but they would have the same influence with much less money, because it is not the absolute level of a rich person’s campaign contributions that sways elections but the level relative to contributions by other rich persons supporting competing candidates."

.............. Aah, Yes, so we've "competing" typically wealthy candidates supported by the rich? Thus a min wage that has eroded to considerably less purchasing power than it had 30 years ago? And NOT a problem that wages for them and the lower quintile will not cover the most basic standard of living and must be subsidized by an alphabet soup of costly and inefficient transfer programs?

These guys! Whew! Again the Republican mantra that those of the topmost tiers won't do their best w/o outlandish "performance bonuses" or CEO "compensations" 400 times that of those doing the work, while increasing numbers are expected to gleefully do their best at grinding tasks and be content to return to subsidized housing, tally up their food stamps and hope the few hundred bucks from the EITC will come in before the brakes go completely out on their aging vehicle.

"Warren Buffett warns that without stiff inheritance taxes (which the United States does not have), we will find ourselves in the grip of an “entrenched plutocracy” (according to the Economist article that Becker cites). I don’t understand that concern. The heirs of the rich spend their money on consumption or investment, just like their parents; dissipate it rapidly, if they’re dumb; but in any event do not by virtue of having inherited a lot of money block the upward striving of others."

.......... I'll side with the savvy Buffet. Having a large inheritance or even a charitable family trust to run gives one instant access to the ruling class and dispensers of favors. As for the dumb one's dissipating a family fortune our tax laws are already VERY favorable to maintaining a bundle as compared to earning a bundle. An inheritance tax (the Brits call it "death duty") WOULD help to erode the fortunes of the indolent who didn't responsibly invest their inherited capital. Do wealthy Republicans fear their offspring will be so inept as to not be able to compete despite the fortune remaining after a reasonable inheritance tax has been paid?

As for:
Poverty is a problem, but if the rich are not a problem, then the problem of poverty is not a problem of inequality. It looks like a problem of inequality only because the wealth of the wealthy seems an obvious source of money to alleviate poverty. But it is not that taxing the rich would alleviate poverty, but that taxing the rich and using the tax revenues to raise the incomes of the poor would alleviate poverty. Inequality should be a non-issue in the United States—and to a considerable degree it is.

......... "should be?" Well perhaps. But look where we've ended up over the last 30 years. The US, hardly a highly taxed nation experimented with tax revenues well below expenditures for the 12 years of Reagan and HW resulting in a quadrupling of the national debt.

With the luck of a strong economy accompanied by tax rate increases and spending discipline during the Clinton era we had a couple years of nearly balanced budgets, perhaps a bit of "surplus" for the predictable rainy day, and "concern" from Gspan as to how bonds would be priced if we paid them all off. Gee! what a terrible problem to have!

Next? Comes a guy spurning public election finance in favor of oodles of money raised by millionaires in fund raising groups deemed Rangers or Pioneers by the amounts raised with another billionaire acting "independently" to tar McCain's reputation in SC after Bush took a beating from him in NH. Then! a "win?" based largely on offering tax cuts heavily skewed to reward the wealthy with only the, curiously, unquestioned "reasoning" of "...thinking no one should pay more than 1/3rd of income".

Followed NOT by any effort to reduce spending but in fact the largest increase in the size and cost of government since the WWII build-up. This in the first year before "deciding" to embark upon the costly "go it alone" invasion of Iraq.

Now we have interest on the resulting D E B T that is fast becoming a bill the size of our bloated military budget. And? are the rich asked for ANY sacrifice? Not at all. No, "all of a sudden" it's working folk including those in the trenches at all levels of government likely to take pay cut, forced furlough or lose their entire incomes. And sorry, while we "really, really, really" want to invest in education at all levels so as to compete with those doing exactly that and put a few of our unemployed to work patching up tattered infrastructure, "we just don't have the money".

Obviously, some cutting over time is necessary with H/C costs and Medicare being the "problem child" in the near future. But is there wisdom in cutting even bloated military acquisition budgets, or is it politically possible when the economic outlook is so poor?

And why is increased revenue the great taboo of today? Truth is income taxes are a lower percentage of GDP than in recent or post WW history. It's only the regressive SS taxes that much higher than in past years.

Is it not time to quit the three decades of coddling the rich and ask them to do something for the country that has served them so well? There is NO way to "cut" our way out and if we try we'll see our economy in worse shambles than it is today.

(If tempted to play the "class warfare" card......... please review the 2nd graph down to see who already won the war.)

"...but in any event do not by virtue of having inherited a lot of money block the upward striving of others."

It seems to me that Dr. Posner has dodged the real issue here: what is the value to society of allowing large intergenerational transfers of wealth? I see very little to recommend it.

Large estates are accumulated through education, industry, perseverance and luck - and a fertile commercial environment to which all Americans contribute. Differential achievement is an important factor in maximizing the productivity of that fertile environment, inherited wealth is not.

Posner writes that "Inequality should be a non-issue in the United States—and to a considerable degree it is." I believe that claim is wishful thinking and that the second half of his statement ("to a considerable degree it [inequality] is [a non-issue]") is simply unrealistic.

The liberal-conservative divide in contemporary American politics is not merely a reflection of the debate between larger or smaller government but the conflict between economic equality and economic freedom. The American left desires greater equality at the expense of freedom while American conservatives reverse the weights. Many controversial political issues can be understood almost entirely through this lens.

Affirmative action aims to alleviate disparities in income and wealth between races; gender preferences in hiring and school admissions are also intended to close the gender gap of pay between men and women; such policies attempt to shift the demographics of an industry towards a more equal representation (consider the National Science Foundation's ADVANCE program that aims to increase the representation of women in math, science, and engineering in academia); maternity leave is often politicized into an issue of economic justice and a tool in the breaking of the "glass ceiling" rather than being understood as merely an accommodation.

Feminists see abortion as vital in female equality; the ability to terminate an inconvenient pregnancy means that a woman who becomes unexpectedly pregnant can more easily continue in her profession or her schooling without depending on support from a male; women will have work experience, education, and earning power more comparable to men when motherhood is delayed or less frequent.

The new health care law was billed as a way to achieve greater equality in the access to health coverage; many advocates declared that access to health care is a civil rights issue because many of those who do not have insurance are lower-income minorities; lower income earners may qualify for subsidies towards the purchase of insurance; women may not be charged higher premiums than men; those with pre-existing conditions may not be denied coverage or even charged a higher premium; the highest premium paid (usually by those aged 65 or older) for a particular insurance plan may not exceed three times the lowest premium paid (usually by young adults) for that same plan - a price restriction that invalidates many of the high deductible insurance plans purchased by individuals who do not receive insurance through their employer. Like health care reform, education reform is often discussed in terms of equality and as a civil rights issue.

Controversies over tax policy often hinge in issues of equality. Posner alluded to the debate over extending the Bush-era tax cuts which included call for raising taxes on those making more than $250,000 in salary and raising the estate tax for larger estates.

I would like to conclude by addressing a point raised by someone posting in the comments section who identifies himself as James Thomas. He suggests that Posner has not properly addressed the concerns of those who want a stronger inheritance tax:
"[W]hat is the value to society of allowing large inter-generational transfers of wealth? I see very little to recommend it. Differential achievement is an important factor in maximizing the productivity of that fertile [commericial] environment; inherited wealth is not."
Although inherited wealth may not be vital in directly maximizing productivity, allowing individuals to leave a large estate to others of their choosing is not a trivial matter. If someone is told that they will not be able to leave wealth to their children, for example, without their children paying a heavy estate tax then it may undermine the productivity level of that individual because the marginal benefit of increased productivity has declined. Furthermore, a heavy estate tax may induce increased wasteful spending ("you can't take it with you") as a substitute to leaving a larger estate ("you can't give it to who you want"); this creates a net social loss.

What is appalling is that this is offered as if there is so truth or science behind what was said.

Hopefully, an uninformed reader will understand that economics has nothing to say about how income is distributed, because the distribution of income has nothing to do with economics. How income is distributed and to whom is entirely a political question.

For example, our political system decides how long Jobs has patents and copyrights that create the only value extant at Apple. Copyright determines the value of Disney. I could go on and on. Hopefully the reader has something of an open mind.

What economics does teach, over and over, is that as income inequality rises, the median standard of living of everyone declines. About this there is no dispute.

What we can say with certainty, which Posner never mentions (of course) is that as income inequality has increased in the United States in the last 35 years, investment and growth has declined, leading to decline in real income for the last decade.

The reader is directed to Innovation Is Doing Little for Incomes
By TYLER COWEN
Published: January 29, 2011, NY Times Cowen observes:

"The income numbers for Americans reflect this slowdown in growth. From 1947 to 1973 — a period of just 26 years — inflation-adjusted median income in the United States more than doubled. But in the 31 years from 1973 to 2004, it rose only 22 percent. And, over the last decade, it actually declined."

In other words, growing income inequality has lead directly to a decline in median income.

The solution is not economic, it is political--taxing wealth and spending and investing.

"What economics does teach, over and over, is that as income inequality rises, the median standard of living of everyone declines. About this there is no dispute."

I often mention JFK's inspirational speech hoping for "a rising tide that lifts ALL the boats". As you, he makes the case for all participating in the productivity gains that create additional per capita wealth.

Family income is somewhat like oil for your car's engine; too little creates real and immediate problems, having enough and things go well. Economists have studied "happiness" as incomes rise, and, of course the rate of "happiness" per marginal dollar decreases rapidly.

None of us favor a flat income curve, but it's worse than senseless for a wealthy nation to have grinding poverty for 20-40% of its people while huge income and wealth continues to pile up in the hands of the top one, or perhaps 2% of the people.

The problems, as we see today, are a destroyer of democracy. Instead of seeing ourselves as "demo", we THE people, instead there are those at the top "feeling" that they pay most of the taxes (largely true, as if you have most of the income, sans trickery, you do pay most of the taxes) while down below are those earning a token wage and becoming increasingly dependent on one costly and cumbersome transfer program or another.

And what of the neutering of the basic power of capitalism to deploy scare resources efficiently when those closest to the capital cream off far too much for what little productivity (if any) that they "create" while those at the lower incomes are subsidized by the taxpayers to do jobs that might not be worthy of doing at all were it not for the subsidy.

If McD's or Walmart's biz model doesn't work without their employees being heavily subsidized (ONE billion a year for Walmart -- the wealthy heirs of which were much of the impetus for Bush getting rid of the "death tax") then honest capitalism would dictate they change biz mod...... or become creatively destroyed that something better rises in their place.

(Some older readers will recall McD's, Ray Kroc setting the record for campaign donations to Nixon with the quid pro being that of keeping the min wage low.)

Aaah, yes and the politics? It seems that for decades now THE trigger most likely to cause the Fed to tighten would be that of "wage inflation". No such alarms or responses are set off by soaring compensation inflation at the top.

"Although inherited wealth may not be vital in directly maximizing productivity, allowing individuals to leave a large estate to others of their choosing is not a trivial matter. If someone is told that they will not be able to leave wealth to their children, for example, without their children paying a heavy estate tax then it may undermine the productivity level of that individual because the marginal benefit of increased productivity has declined. Furthermore, a heavy estate tax may induce increased wasteful spending ("you can't take it with you") as a substitute to leaving a larger estate ("you can't give it to who you want"); this creates a net social loss.

........ Let's keep in mind that the estate tax is hardly confiscatory and that it affects only a very few and rather large estates.

......... What is "wasteful spending?" Posner posits: "All their money is either spent on consumption or invested, and either way it is economically productive;" And it may encourage some to do more charitable giving, ala Gates and Buffet. Others may realize that the portion going to Unc Sam via an estate tax puts it to work as well, after all those making it big over the last 30 years have been paying less in taxes than we've received in benefits. (ie deficits and resulting debt)

In a discussion of our acceleration of inequality and the "need" for huge incentives at or near the top there's something else to consider.

First that of our military. Despite a downside of extremely uncomfortable living situations, being wounded or dying, they do it. The "upside" is that of making incremental increases in rank with small pay increases, and perhaps a medal or an award of some kind.

There's another "army" as well, much bigger than the military; the teachers who with no expectations of either getting rich or being awarded "performance bonuses" beyond an apple or box of cookies do their jobs every day to the best of their abilities. So too do our police (more dangerous than military service) firemen and others.

Don't bother with the Mitchells of this World. He lives in a dreamland. What fools like him don't understand is the real world. Most same businesses, except for farms, are service businesses that have no value to leave to anyone. Insurance, accounting, law, medicine, construction, etc., are not businesses that can be "sold" or passed on by inheritance, especially because while the owner is alive that have to pay incomes taxes and FICA taxes.

John..... thanks! And as a matter of public policy I'd rather turn may attentions to those who'll inherit nothing than those fretting about pitching in some taxes on amounts over several million bucks.

Ha....... am reminded of and old song "Papa was a rolling stone.......... all he left us was a loan.."

As you point out even professionals of the service sector have little to sell and with far more working for companies, the passing on of family fortunes is a fairly rare "problem". Rove, was again an evil "genius" to label the inheritance tax a "death tax". I'm sure a poll would show 50% thinking they'd have to pay something on passing.

I think both of you are also missing how much of increased inequality is due to decreasing **some** forms of social inequality or status compensation which then forces firms to motivate people directly in monetary terms.

To take a simple example, if company A used to reward their top execs with free golf club memberships and nice art on the walls but now is pressured to cut those things out, it'll have to pay more to top execs. Measured inequality goes up but not actual inequality. Furthermore, a lot of top "compensation" wasn't in the form of direct perks but freedom from competition. E.g. If laws made CEOS less subject to takeover and firing before, they'll have to compensate for higher risks now with more pay. In other countries highly restrictive social arrangements keep "outsiders" from intruding in ways that are unthinkable in the US as competition and mobility have increased.

I believe you see this in academia. Wasn't there a study of economics dept which showed that as strong profs in the top 10 econ programs became more mobile the salary gap between the top 10 and everyone else started to increase?

In the United States, as income inequality has increased over the last 35 years, investment and real growth has slowed and, now, the standard of living of the average american and american family is declining.

These are facts, cold, hard facts.

Marxist don't worry about a lack of investment. Capitalist like myself worry about a lack of investment that leads to a decline in income---purchasing power.

Fools like you don't know the importance of investment

Fools like you don't ask, if something is wrong with a picture, "What's wrong here?"

My perspective is that declining income for 99.5% of a population is a really negative psychological factor for investors. I would argue a similar experience is with the South and slavery. As the problems with slavery became more evident, investment in the South sharply declined.

Today, you can see a similar experience in Egypt. You don't see capital rushing toward that uncertainty.

Tans! It IS good to bring up Marx but for his prescient vision early on in the history of capitalism of capital being far stronger than labor creating economic cycles that end abruptly as far too much capital becomes constipated among too few. Marx predicted peasant revolts, we were lucky to instead have FDR and something of a "New Deal".

Today the concentration of wealth in few hands is like that of 1928.......... shall we try to avert repeating the past?

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Posner posits: "All their money is either spent on consumption or invested, and either way it is economically productive;"

Is spending always "economically productive"? It seems to me that if your house in the Hamptons is now worth 5x what it was worth 5 years ago, but fundamentally it's the same house, then it's not the case that the house itself is worth more, rather, the pile of dollars to pay for it are worth less. Right?

Not to mention, the increase in taxes and cost of living to everyone around you.

Isn't inequality a non-issue in the U.S. because of elegant political-media cooperation? Rather than being pissed off that deregulation has transferred all of their jobs to India and China, where labor costs pennies, in the name of "competition," the former American worker is pissed off that illegal immigrants have moved in next door, or they are frightened of abortion leading to moral collapse.

When the moral collapse is the desperation of people who can't get jobs, don't have the social or intellectual capital to find fulfillment any other way, gorge themselves in cigarettes, processed foods and candy to forget their depression...that moral collapse has already happened.

The brilliance of American politics is in convincing the middle class to vote against its own economic interests in the name of "deeper" values, right??

It's not that inequality is a non-issue. People are desperate and angry. It's just that their anger is misdirected towards other issues, which are not the cause of the real issue: income inequality. Right?

I think economic spending sometimes evaporates value into localized inflation, ESPECIALLY in real estate, while robbing real value from real people, and the wages paid to foreign workers in the name of "global competition" actually have nothing to do with any kind of fair fight, but rather represent a global massacre of workers in rich countries.

Rich people pay ever more money for the same exact assets, so their lives don't materially improve, and when credit runs dry, workers in rich countries are completely devastated and scramble for any message that seems good and pure.

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Income inequality is perverse and it will become an even greater in the future. The unfotunate consequence of capitalism is that the rich have it easier to aquire even more wealth due to advantages that come with resources. http://www.frontiereconomy.com had a great article about this subject about this subject a while ago. All in all it seems we are heading towards more social conflict.